Sharing an email exchange with a reader and I hope to hear what readers have to say:
Hi AK,
I am P, one of your loyal followers in your blog. I have a silly
question that I ponder the past 2 days that I could not decide. So, I
thought you are very financially wise, maybe you can help me.
It is like this: I am 45 years old. I am thinking of buying an annuity
that will gave me $300 per month for life from age 65.I need to pay 10
years of premium totaling $45562. If I die at age 66, my dependents
will get $50, 798. This is the same for my dependents even if I die at
age 86. If I die at age 86, I will get $300 per month for 20 years.
Another alternative, I could invest for income and maybe buy OCBC
shares, I will get a rate of 3.5 per annum. It seems higher.
I am at a loss at what to do, what will you do if you will me?
Assuming that you do not invest in high yield income and only at OCBC
shares. What will be your considerations? For me, I am more worried
about my dependents and hope that they will be happy and not to always
worried about money. That is why I hope to give them an income for
life. It is the only thing that a mother can best give to her children
and also to teach them to be financially literate.
Hope you can help me.
Thank you, AK for your kindness.
Regards
P
My reply:
Hi P,
I am not a financial advisor. So, I am not going to give you any advice on this but I will share with you what I think.
You did not say when must you start contributing to this annuity which will accumulate over a 10 year period. So, I will assume that you must start contributing now at 45 years old since you are thinking to buy one now.
I will also assume that you are contributing the same amount every year over a 10 year period. Total: S$45,562 means S$4,556.20 a year.
The guaranteed payout is S$50,798 in the event of your death at any time from age 66 to 86. Otherwise, you would get S$300 a month over a 20 years period or a total of S$72,000.
The attraction of an annuity plan to me is really the predictability it provides which is important in our old age. Of course, we hope that the insurance company doesn't go bust.
Now, predictability is good but is it that difficult to do better than what an annuity promises to do for us?
Assuming inflation is 3% per annum, the initial sum of S$45,562 which you have progressively contributed from age 45 to 54 should become at least S$54,798 at age 55 just to keep pace with inflation. By age 66 when you start drawing $300 a month, this sum should then become S$73,644.
A 5% draw down per year from age 66 would give you about $307 a month which approximates the $300 a month you have been offered. Assuming that nothing is done to the money to grow it over the 20 years draw down period (e.g. keep the money in a biscuit tin), the money would be depleted over the same time period. Don't ask me what happened to the excess $7 a month.
The annuity will deliver maximum monetary benefit to you and your estate if you were to live up to age 85 years and 11 months. Total benefits: S$ 71,700 + S$50,798. To me, it is almost like a game of chance and it probably is.
Now, assuming that you did your own investments and you managed to only keep pace with inflation at 3% per annum, that S$73,644 you would have accumulated by age 66, if invested, would probably still grow at 3% per annum and even with that 5% draw down a year, you would not end up with nothing at age 86.
After 10 years, at age 76, by my calculations, you would still have S$53,907 for your estate. After 15 years, at age 81, S$43,380. At age 86, $28,512.
Hypothetically, if you could consistently receive a 3.5% yield by investing in OCBC alone, the difference is even more stark and would beat this annuity plan flat.
Of course, share prices will most likely fluctuate but if the business is strong and grows over time, that 3.5% yield on cost is likely to grow as well and with it, the share price of the company.
Best wishes,
AK
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